WORKSHOP ON DEBT, FINANCE AND EMERGING ISSUES IN FINANCIAL INTEGRATION LONDON, 6-7 MARCH 2007 DOMESTIC DEBT AND ACHIEVING MDGS IN LICS Presentation by Dinesh Dodhia Rappidd Consultancy Ltd

Introduction MDGs major challenge for LICs: Sub- Saharan Africa far from achieving by Key requirement: Govt. & donor resources targeted at MDGs. Debt servicing: claim on Govt resources: external debt (ED) reduction to HIPCs Govt need to service domestic debt (DD), which if freed, could be utilised for MDGs

Domestic Debt in LICs: Some Stylised Facts 66 LICS ( ) av. DD/GDP ratio & DD//TD= about 20%. Non-CFA African HIPCs (1980s/90s) DD/GDP=6-9%, but DD/TD fell 22% to 6%: End-2005 DD/GDP significant in Guinea- Bissau, Ethiopia, Sierra Leone, Burundi, Zambia & Guinea. DD taken hold in CFA HIPCs LA HIPCs sharp increases in , but reduced.

Domestic Debt in LICs: Some Stylised Facts Other African LICs, Kenya & Nigeria significant reliance: Kenya up Nigeria down Asian LICs, Sri Lanka DD/GDP=47% TD/GDP=100% DD/GDP underestimated LG & SOE debt excluded arrears & other un-securitised debt not clear CLs can be very large. DD/TD expected to increase with ED reduction

Fiscal/Budgetary Impact of Domestic Debt Burden Non-CFA Af. HIPCs ( ): despite DD/TD decline DISP/TISP>40% AIDIR=21% AIFIR=1% 66 LICs ( ) DISP/TISP> 40% RDIR= 3%. Govts resorted to domestic borrowing to reduce external vulnerability cap on non-concessional external borrowing in IMF programs. Recently RDIR fallen, but in CP HIPCs Ethiopia, Zambia & Tanzania DISP>FISP Sri Lanka DISP/GDP=6%, EISP/GDP=0.7%

Short maturity structure Shallowness of financial sectors Concentration of the investor base Fiscal/Budgetary Impact of Domestic Debt Burden

HIPC Initiative established ED thresholds & relief given to bring ratios below thresholds Did not preclude IMF considering DD burden, when serious macroeconomic concern (2003 programmes of Bolivia, Ghana and Nicaragua) Debt Sustainability & Domestic Debt in LICs

Debt Sustainability & Domestic Debt in LICs IMF/WB DSF: forward looking DSAs assessed in relation to indicative thresholds to establish risks of debt distress Advising the strategies of lending institutions, especially IDA in determining grant/credit mix. IMF/WB against DD in DSF due to difficulties of determining empirical thresholds: lack of historical data series, different characteristics of DD & ED purpose of DSF to guide official lending decisions.

CHMF: Need to work out prudential ratios for DD through more research & analysis. DD/GDP=10% typical African HIPC, situation varying according financial depth, with TPD/GDP= 40-60% depending on policies and institutions. MDRI: bringing down NPV ED ratios well below DSF indicative thresholds perverse effect giving non-participating HIPC creditors less incentive to provide debt relief increasing complacency of governments on tackling DD shortcomings Debt Sustainability & Domestic Debt in LICs

HIPC Initiative predated MDGs, although underpinnings with poverty alleviation. MDRI more explicit link Should DD holders provide debt relief internal borrowing: transfer of purchasing power within country. Debt cancellation by DD holders: a tax. Positive: if resources released used by Govt for MDGs Rationale for Debt Relief, MDGs & Domestic Debt

Rationale for Debt Relief, MDGs & Domestic Debt Negative: if resources transferred affected private sector activity, growth & poverty reduction. reneging trade contractual payments affected willingness of private sector to provide future credit to Govt securitised debt holders deterred from holding future government debt, adversely impacting on dev of financial markets. action that serves to reduce the high DD servicing burden, through debt restructuring: benefit to MDGs

Rationale for Debt Relief, MDGs & Domestic Debt Should donors reduce DD stock If existing aid diverted to reduce DD Negative: resources taken away from MDGs, unless further rebalancing of public expenditure, Positive: would support private sector credit & investment, hence long term growth, poverty alleviation & MDGs. Government’s credit standing improved resulting in lower future debt servicing cost Constraint on reducing DD eased if additional external resources utilised for DD reduction

Dealing with DD Burden: What can LIC Governments Do? Improve DD database set up of machinery to verify arrears claims, including agreement on disputed claims, with recording on central register. promote centralised data on CLs Make norms Total public DSA MDG scenario

DS dependent on macroeconomic variables, having bearing on MDGs Need to focus on Measures to enhance growth, Maintaining strong anti-inflationary policies to ensure low interest rates Maintaining fiscal discipline, while enhancing MDG related expenditures Reforms to reduce quasi fiscal costs associated with SOEs Dealing with DD Burden: What can LIC Governments Do?

Domestic Debt Restructuring use opportunity of low inflationary & interest rate environment to refinance expensive debt instruments explore prospects for lengthening maturity structure of DD instruments by test issues without significant increases in yields. Develop policies to broaden investor base Dealing with DD Burden: What can LIC Governments Do?

Dealing with DD Burden: What can LIC Governments Do? Securitize arrears to ensure orderly settlement Offer incentives to settle upfront a certain proportion of arrears or all credits up to a certain limit seek debt reduction along the model of Brady bonds

Domestic Debt Reduction & Donors Donors’ role in providing grants, other concessional aid & exceptional financing through debt relief DD candidate most suited for providing future donor debt relief Assist LICs to clear verified arrears, fully or partially with the remainder securitised.

Domestic Debt Reduction & Donors Assist LICs to reduce high DD ratios: options below a uniform threshold, (10%): added benefit of retiring short term debt & improving DD maturity profile Negative: does not distinguish between different LIC circumstances Reduce DD according to LIC circumstances but depends on IMF diagnosis & willingness of donors to provide additional resources.

Domestic Debt Reduction & Donors Insert degree of automaticity based on individual LIC circumstances DD/GDP relief not > 10%, with eligibility for HIPCs with DD/GDP>20% or TPD/GDP % depending on the quality of policies & institutions. Assist LICs to extend DD maturities by guaranteeing interest payments on the later portions of maturity Provide TA for development of long term institutional investors

Domestic Debt Reduction & Donors Provide TA for debt management WB proposal: global debt management partnership providing TA on a standardised diagnostic tool & work with select group of LICs demonstrating commitment to sound debt management. Related idea: donor funded partnership for capacity building, dissemination of international best practices & knowledge transfer on domestic debt management